Opinion

The Great Debate

Uncertainty paralyzes U.S. banking system

November 28, 2008

John Kemp Great Debate– John Kemp is a Reuters columnist. The opinions expressed are his own –

Extreme uncertainty about the economic outlook and the depth of the recession has paralyzed normal lending activity by commercial banks in the United States and elsewhere. Even as the Federal Reserve has added liquidity and boosted bank reserves, the credit creation process has remained stalled as banks struggle to identify good borrowers willing and able to repay in a wide range of future economic conditions.

The attached chart is adapted from the Federal Reserve’s weekly H.8 release on “Assets and Liabilities of Commercial Banks in the United States” (https://customers.reuters.com/d/graphics/US_CRDT1108.gif).

It shows the ratio of loans, leases and interbank lending (risk assets) to vault cash, reserves and Treasury securities (safe assets) held by U.S. commercial banks. In essence it shows the commercial banking system’s appetite for risk and capacity for credit creation.

Credit is clearly cyclical. But the period since 1994 has witnessed a huge increase in credit extension and a massive rise in balance sheet risk overlaid with modest cyclical variations. Following a brief hiatus during the downturn of 2001-2003, explosive credit creation resumed and hit new heights in early 2008.

The ratio of loans, leases and interbank loans to vault cash, reserves and holdings of Treasury securities has increased from 2.4 in April 1994 to 3.2 in Apr 2004 and a staggering 5.3 in Apr 2008.
Since the onset of the crisis, the lending ratio has plummeted to 3.5. It is the sharpest reversal in balance sheet composition since the 1930s.

In fact, commercial bank lending has increased slightly since the onset of the crisis. Increased loans and leases have offset a downturn in interbank activity. Some of this reflects the reclassification of investment banks as commercial ones.

The rest was probably “involuntary” lending as corporations unable to access other forms of credit drew down standby committed lines.

But the massive expansion of Fed lending facilities has boosted commercial bank assets by $500 billion since the end of August. All this additional money has been placed on deposit with the Fed or invested in Treasury securities (+$701 billion) more than offsetting the flight from other loans and securities (-$200 billion).

The credit crunch has manifested itself in an extreme preference for low-yielding but ultra-safe assets.
The massive cushion of cash and cash-like assets held by the commercial banks has dispelled any residual doubts about their short-term liquidity, as it was designed to do.

But by shifting their balance sheets in this way, the commercial banks have essentially blocked the monetary transmission line from the Fed to the rest of the economy, ensuring that monetary easing has not filtered through to Main Street, and forcing the Fed to turn to more unconventional measures to get credit through to the economy.

Comments
19 comments so far | RSS Comments RSS

There’s a great book that explains much of this shady financial activity called “The Coming Battle” By. M. W. WALBERT. COPYRIGHT, 1899. It’s a history of banking from
1776-1899. The book will give you a good idea as to how we arrived at this point of financial catastrophe.

Posted by Jason Kloster | Report as abusive
 

Are we sure we want people to borrow more? With US consumers afloat on something like $14 trillion of debt and lashed down to still-falling asset values, don’t we really need to discourage more “eat-drink-and-be-merry-for-tomorrow
-we-die” borrowing?! I understand the urge to spend our way out of recession, but can/should we try to spend our way out of debt?

Posted by William Crane | Report as abusive
 

Not all borrowing is of the “eat-drink-and-be-merry-for-tomorrow
-we-die” variety. A friend of mine owns a business and has been planning an expansion to other sites. But even he can’t get any banks to give him money, no matter how surefire his business plan seems to be, because they just don’t want to lend. So the failure to lend is curtailing good business growth, too, and that’s a problem.

Posted by Calamity Jean | Report as abusive
 

For sure if people became more of a credit risk, I would offer them more money at lower interest rates. No wonder the U.S. financial system is operating so well.

Posted by Don | Report as abusive
 

Another Reuters article today says that investors are running to the “safe haven of Government bonds”. Can’t that also become another bubble? The Congretional budget process looks like a joke now. What will be the point of Congress quibbling over hundreds of millions for hundreds of smaller Federal programs when trillions of dollars – I read anywhere from 1.5 to 7 trillion in new debt – has been piled on without much concern for how the government will pay for it? All of that debt is expected to pay for itself – that is the theory anyway- but only if the economy returns to robust health. If it remains weak won’t that contribute to another even larger disaster?

What will happen to that “safe haven” when the sovereign funds and others get nervous about the sudden and enormous US government debt exposure?

The fact that every other developed country is doing the smae thing may help us but couldn’t that also mean that all the developed countries could find that their tresury bonds all get hurt at the same time?

What happens to the world economy when all the “wealthy” countries begin to see that they are essentially bankrupt? Will “relativilty” save us? There is no Chapter 11 for states, is there?

Posted by Paul Rosa | Report as abusive
 

There is even a greater book telling us what we did wrong, what we need to do to fix it and how we should live after fixing it, it is called The Holy Bible and it withstood the test of times.

Posted by Chunga | Report as abusive
 

Paulson, Bernake, Congress, and executive branch has there head in the sand. They infuse the financial markets with taxpayer money and what do these institutions do? They reduce credit limits on credit cards for good credit customers. I had a customer with a 780 credit score with 25,000 limit on a citibank card watch thee limit be reduced to 2500 which is just above the balance each month which is paid off in full. That increases his utilization to 100% from 10%. The credit score will take a beating and the shift from prime to subprime begins becuase of the greed of banks and the love affair with subprime margins. When will people start reporting on what is happening here. The credit rating agencies are part of the problem, send the feds in to investigate their practices.

Posted by Greg | Report as abusive
 

It all boils down to the fact that a few decades ago in the early 20th century the US constitution was savagely violated by people in the government with the help of special interest agents not elected by anybody. Ever since then the violation has been rising proportionally to the debt load. This violation will result in the collapse of USA, ultimately.

 

Yeah we should look to the bible, the church has figured out a way to sustainably fleece people for centuries.

Posted by Asstackler | Report as abusive
 

no, it is actually paper based curerency created by central banks and commercial banks out of thin air which has parralized the world banking system eversince we departed from commodity (gold) standart with 100% bank reserves, I strongly recommend Austrian School of Economy for more detailed explanation, http://www.mises.org

Posted by Mark | Report as abusive
 

The banks do not lend not because they do not like to, but because they are short of liquidity. In fact most of the bank long term lending is based on short term borrowing. If they can not borrow to replenish their short term credit resources to further finance long term loans, they have to stop issuing new loans. The bank can not just call a good 25 year loan back just because they have no further lending resources.

Posted by Giedrius | Report as abusive
 

The more facts that are exposed (which obviously lowers uncertainty), the worse the obvious situation becomes. What’s hidden is all bad, and casting light on the hidden will only adversely affect the economy (for example, the highly volatile stock markets typically rise on optimistic opinions or miss-interpretations of data, and plunges on hard facts. Also, some of us have recently discovered that the economy has been in recession since December of 2007!).

Of course, the truth will out eventually. But it’s clear that US government propaganda, supression of meaningful data, and manipulation of stock and gold markets have only made the long term situation much worse and much more volatile.

 

Anybody remember the scene in the Michael Moore movie Fahrenheit 911 when Dubya is talking to a meeting of the elites and he says straight out, “I’m your guy!!” We are now seeing what happens when a kinder gentler fascist moron signals to the pinnacle of amoral corporatist pirates that under his reign, anything goes. I guess quite a few of them might take advantage of the situation by creating insane levels of leverage so that they can generate phony profits and get those multi-million dollar bonuses.

The house of cards is now collapsing, but I fear that so far we have only seen the collapse on the top few stories of this fragile edifice. Before its over, there will be a lot of excess suffering in this world. It may be that the only cure is prosecution and bringing these mercenary traitors to justice.

Posted by Jonathan Cole | Report as abusive
 

Yes, the world financial system is based on systems developed ad hoc thousands of years ago, when we were that much closer to our ancestral roots as amoebas in the ocean. So, forget everything you know. The word of the day is REDESIGN.

Redesign everything, from the financial system to the education system and from the English language to mathematics. We need to constantly redesign everything forever. We are all there is in this area of the universe, so it’s really up to us to make it happen.

Posted by Yes, I agree with all of you | Report as abusive
 

All this stuff started with Enron and the way they operated. It was the darling of Wall Street and bankers copied their ideas and used them and gorged on it. In a room full of smoke and mirrors people get hurt so SPV’s need to be brought on to balance sheets and assets deflated rather than hyped up in value. Other wise we will all end up like the late Ken Lay’s Enron, instead of Arthur Anderson being destroyed it will be Governments rather than auditors.

Posted by Mark Walklate | Report as abusive
 

Regarding the person with a FICO score of 780, and a credit card debt of 2500. When that situation came about, he should have paid off the 2500$ immediatly so that his utilization would be 0%.
Then, he should shop around for a different credit card.
Many ways to skin a cat….

 

I was reading that goldman sachs will report 2 billion dollars loss for the fourth quarter. This means that all these Zombie companies and banks lived artificially from loans from other banks and the Fed. what will happen when these loans are due or dry up. Another crunch???

Posted by DOOMSDAY CLOCK | Report as abusive
 

but micro economic moves only tend to work on national debt and decrease gnp which mind you is determined by the overall function of the national product. Is inflation looming if and when banks disseminate this newly acpuried capitalamong the populace or will they tighten up standards causing a surplus and shift to in house(bank) spending. In other words will main street be rescued by uncle sam or just passified until big business gets its marketing strategy in order. To pouch upon poor customer in revenge for his part in the THE CREDIT CRUNCH

Posted by john wade | Report as abusive
 

Why does not the governament creates small bank agencies to help the families?

 

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